The small and mid-cap Smithson (SSON) investment trust has released its first set of results.  These reveal a number of interesting financial metrics for the Smithson portfolio. Smithson appears to be better placed than the main Fundsmith Equity Fund.

Interim financial results from Smithson (SSON) allow us to look under the hood at the £1 billion closed-end fund. Investment trusts are required to detail the whole of their portfolios when they release interim or full-year results.

Smithson share price and NAV since the IPO

Source: SharePad

Perhaps more importantly, Smithson has calculated a number of key look-through ratios for its portfolio. The return on capital employed for Smithson was 39% at the end of 2018 versus 29% for the Fundsmith Equity Fund.

The quality (ROCE) of the Smithson portfolio is therefore 34% higher than the quality of the Fundsmith Equity Fund portfolio. The operating profit margin for the Smithson portfolio was 31% versus 28% for the Fundsmith Equity Fund.

Cash conversion for the Smithson portfolio was 110% in 2018 versus 95% for the Fundsmith Equity Fund. Interest cover for the Smithson Portfolio came in at 30X versus 17X for the Fundsmith Equity Fund.

Key ratios at the end of 2018

Methodology: Weighted average except for interest cover. Rightmove excluded from Smithson ROCE.

Source: Fundsmith, Smithson

What are the key quality takeaways?

Smithson appears to have a much higher quality portfolio of stocks than the Fundsmith Equity Fund. Smithson’s portfolio generates higher returns, converts more profit into cash and the interest cover is much higher.

The return on capital employed (ROCE) is a function of the operating margin and capital turnover ratio. Smithson’s portfolio ROCE is 34% higher than Fundsmith while the operating margin is only 10.7% higher.

This implies that companies in the Smithson portfolio are less capital intensive (sales divided by capital employed) than the Fundsmith Equity Fund portfolio. Small and mid-cap companies generally have scope for organic growth.

Valuation and growth

The Smithson portfolio traded on a 4.2% free cash flow yield at the end of 2018 versus 4% for the Fundsmith Equity Fund. Free cash flow for Smithson stocks increased by 16% in 2018 versus 8% for the Fundsmith Equity Fund.

On face value, therefore, the Smithson portfolio is cheaper and faster growing that the Fundsmith Equity Fund. We are, however, only looking at growth in a single year.

The Fundsmith Equity Fund saw robust free cash flow growth of 13% in 2017. With Smithson focused on mid-cap and small companies the portfolio should, in theory, see stronger free cash flow growth than the Fundsmith Equity Fund.

Summary

The Smithson (SSON) Investment Trust is intriguing.  It certainly merits a closer look and Fund Hunter will endeavour to have a closer look soon.  It is notable that Fundsmith's other Investment Trust - Fundsmith Emerging Equity Trust - hasn't performed well as the main fund.

Smithson (SSON) is focused on developed markets rather than emerging markets.  It should be easier to pick good companies in developed markets with less scope for things to go wrong.